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Endogenous uncertainty and the non-neutrality of money

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  • Maurizio Motolese

Abstract

We study some implications of the Theory of Rational Beliefs to monetary policy. We show that monetary policy in a Rational Beliefs environment can have an important effect on the characteristics of economic fluctuations. In Rational Beliefs Equilibria money is generically non-neutral unlike Rational Expectations Equilibria in which money is neutral and monetary policy is ineffective. Under Rational Beliefs Equilibria nominal prices and real output change not only in response to changes in the exogenous growth rate of money but also in response to changes in the state of beliefs. In Rational Beliefs Equilibria monetary shocks have real effects even when they are observed but are not fully anticipated. Furthermore, the non-neutrality of money results in a short run Phillips curve. When money “flutters, real output sputters” [8]. We show that Endogenous Uncertainty and the distribution of market beliefs are the major explanatory variables of such fluctuations. Under Rational Expectations monetary policy is ineffective because agents neutralize it by predicting correctly the effect of the policy. Under Rational Beliefs it is shown instead that inflation and recessions can be substantially aggravated by the distribution of market beliefs. Copyright Springer-Verlag Berlin Heidelberg 2003

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  • Maurizio Motolese, 2003. "Endogenous uncertainty and the non-neutrality of money," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 21(2), pages 317-345, March.
  • Handle: RePEc:spr:joecth:v:21:y:2003:i:2:p:317-345 DOI: 10.1007/s00199-002-0293-8
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    Cited by:

    1. Kurz, Mordecai & Motolese, Maurizio, 2006. "Risk Premia, diverse belief and beauty contests," MPRA Paper 247, University Library of Munich, Germany.
    2. Mordecai Kurz & Maurizio Motolese & Giulia Piccillo & Howei Wu, 2015. "Monetary Policy with Diverse Private Expectations," Discussion Papers 15-004, Stanford Institute for Economic Policy Research.
    3. Mordecai Kurz, 2011. "Symposium: on the role of market belief in economic dynamics, an introduction," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 189-204.
    4. Carsten Nielsen, 2009. "Non-stationary, stable Markov processes on a continuous state space," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 473-496.
    5. Kurz, Mordecai & Jin, Hehui & Motolese, Maurizio, 2005. "The role of expectations in economic fluctuations and the efficacy of monetary policy," Journal of Economic Dynamics and Control, Elsevier, pages 2017-2065.
    6. Kurz, Mordecai, 2008. "Beauty contests under private information and diverse beliefs: How different?," Journal of Mathematical Economics, Elsevier, vol. 44(7-8), pages 762-784, July.
    7. John S L McCombie & Marta Spreafico, 2013. "Can only democracies enhance “Human Development”? Evidence from the Former Soviet Countries," DISCE - Quaderni dell'Istituto di Politica Economica ispe0066, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
    8. Hehui JIN, 2007. "Nominal Interest Rate Rules under Heterogeneous Beliefs," Rivista Internazionale di Scienze Sociali, Vita e Pensiero, Pubblicazioni dell'Universita' Cattolica del Sacro Cuore, vol. 115(3), pages 403-442.
    9. Caruso, Raul & Schneider, Friedrich, 2013. "Brutality of Jihadist terrorism. A contest theory perspective and empirical evidence in the period 2002–2010," Journal of Policy Modeling, Elsevier, pages 685-696.
    10. Ernst Fehr & Jean-Robert Tyran, 2004. "Expectations and the Effects of Money Illusion," DNB Staff Reports (discontinued) 115, Netherlands Central Bank.
    11. Mordecai Kurz, 2007. "Rational Diverse Beliefs and Economic Volatility," Discussion Papers 06-045, Stanford Institute for Economic Policy Research.
    12. Kurz, Mordecai, 2006. "Beauty contests under private information and diverse beliefs: how different?," MPRA Paper 233, University Library of Munich, Germany, revised Apr 2006.
    13. Mordecai Kurz & Maurizio Motolese, 2011. "Diverse beliefs and time variability of risk premia," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 47(2), pages 293-335, June.
    14. Kurz, Mordecai & Piccillo, Giulia & Wu, Howei, 2013. "Modeling diverse expectations in an aggregated New Keynesian Model," Journal of Economic Dynamics and Control, Elsevier, vol. 37(8), pages 1403-1433.
    15. Giuseppina Malerba & Marta Spreafico, 2014. "The rich and the poor in the EU and the Great Recession: Evidence from a Panel Analysis," DISCE - Quaderni dell'Istituto di Politica Economica ispe0068, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
    16. William Branch & Bruce McGough, 2011. "Business cycle amplification with heterogeneous expectations," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), pages 395-421.
    17. Nielsen, Carsten Krabbe, 2008. "On rationally confident beliefs and rational overconfidence," Mathematical Social Sciences, Elsevier, vol. 55(3), pages 381-404, May.
    18. Campiglio, Luigi Pierfranco, 2014. "Unbundling the Great European Recession (2009-2013): Unemployment, Consumption, Investment, Inflation and Current Account," MPRA Paper 53002, University Library of Munich, Germany.
    19. Luigi Pierfranco Campiglio, 2013. "Why Italy's saving rate became (so) low?," DISCE - Quaderni dell'Istituto di Politica Economica ispe0063, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
    20. Luigi Pierfranco Campiglio, 2012. "Market's SINS and the European Welfare State: theory and empirical evidences," DISCE - Quaderni dell'Istituto di Politica Economica ispe0060, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).

    More about this item

    Keywords

    Keywords and Phrases: Money non-neutrality; Monetary policy; Rational expectations; Rational beliefs; Rational belief equilibrium; Endogenous uncertainty; States of belief; Phillips curve.; JEL Classification Numbers: D5; D84; E52.;

    JEL classification:

    • D5 - Microeconomics - - General Equilibrium and Disequilibrium
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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